In the world of loans, there are countless factors involved in obtaining a loan for the purchase of a home. This article will give you an overview of the three main loan programs available. When you start looking for loan programs, be sure to contact a mortgage professional for more information and the latest market updates and changes.
FHA insured loans
An FHA loan is a loan insured by the Federal Housing Administration. The FHA was created in 1934 to increase home construction and reduce unemployment through loan insurance, which essentially reduces risk for lenders making the loan. During tough real estate times, FHA loans move into the spotlight and become more important because they allow homeowners to obtain loans often at lower rates and better terms than conventional loans. However, when times are good and investors are willing to take higher levels of risk (2005 boom), conventional loans will offer the most attractive terms for homebuyers.
In today’s market, conventional loans often require 5-10% of the purchase price as a down payment and do not offer the most competitive interest rate. Due to the government insured aspect, FHA loans can have down payments as low as 3% and will allow the seller to contribute (give) up to 6% of the purchase price of the home to the buyer to help them move. At the time of this publication, the government is talking about increasing the down payment amount and getting rid of the seller assistance aspect. Changes made to FHA loans often reflect moves to ensure homeowners can move into their homes and make payments over long periods of time, creating a more stable housing market.
Conventional loans are not guaranteed or insured by the government and therefore do not adhere to the same strict guidelines as FHA loans. A traditional conventional loan requires the home buyer (borrower) to put down 20% of the purchase price as a down payment and the remaining 80% will be financed as a conventional loan. Because the buyer is putting down such a large amount, these loans are often considered low risk and do not require any insurance.
In recent years, conventional loans have evolved to meet the needs of homeowners with very little to put on a home. In this scenario, the buyer would walk in with less than a 20% down payment and would have one of two options. Here is an example to explain the options.
Mr. and Mrs. homebuyer decides to buy a home for $100,000. A traditional conventional loan would have buyers put up $20,000 for a down payment and the remaining $80,000 would be financed/mortgaged. Now, if the buyer only had $10,000 for a down payment, here are the two options they could choose from.
Option 1: Get a large loan of $90,000. Since the buyer would be financing more than 80% of the value/purchase price of the home with the first loan, the buyer would pay private mortgage insurance or PMI. This insurance protects the lender writing the loan in the event the buyer defaults on their loan. The theory is that the higher the loan-to-value ratio (amount borrowed versus the value of the home), the less invested the buyer is and the more likely they are to default for whatever reason.
Option 2: As a way to avoid paying PMI, the borrower can take out two loans. The first loan would be for $80,000 and the second loan would be for $10,000 with the remaining $10,000 going towards a down payment. Since the first loan has a loan-to-value (ltv) ratio of 80%, there would be no insurance premium (PMI). The problem with this loan is that you will most likely pay a higher rate on the second $10,000 loan. Instead of paying mortgage insurance, the borrower would pay a higher premium for the second loan. The higher interest rate is the lender’s way of justifying the risk of the second loan.
The second option is how many homeowners ended up financing 100% of their home and overextending their financial limits.
VA Guaranteed Loans
VA loans are guaranteed like FHA loans, but the Department of Veterans Affairs handles the guarantee. VA loans were created to help veterans buy or build homes for eligible veterans and their spouses. The VA also guarantees loans for the purchase of mobile homes and land to locate them. A veteran who meets any of the following criteria is eligible for a VA loan:
- 90 Days of Active Duty for veterans of World War II, the Korean War, the Vietnam conflict, and the Persian Gulf War
- A minimum of 181 days of active service during the periods of interconflict between July 26, 1947 and September 6, 1980
- Two full years of service during any peacetime period since 1980 for enlisted and since 1981 for officers
- Six or more years of continuous service as a reservist in the Army, Navy, Air Force, Marine Corps, Coast Guard, or as a member of the Army or Air National Guard.
There is no VA dollar limit on the loan amount a veteran can obtain, the limit is determined by the lender. To determine how much of a home loan the VA will guarantee, the veteran must request a certificate of eligibility.
Just as the real estate industry is continually changing, the mortgage industry is also evolving on a daily basis. The general rule of thumb for both industries is that 50% of what you know today will be out of date and useless in three years. This emphasizes the importance of discussing your needs with a qualified loan officer who is continually trained and stays abreast of the market.